EMEA Weekly, Week 2‏

When the Polish central bank’s (NBP) Monetary Policy Council (RPP) meets next week, the main topic on the agenda will be the slowdown in the Polish economy and the NBP’s response to it. In our view, the NBP was far too hesitant in initiating monetary easing in 2012 and as a result the slowdown in the Polish economy has been much more pronounced than would have been the case had the NBP acted earlier and more decisively. Recently, Polish Finance Minister Jacek Rostowski has expressed a similar view and has called for further action from the NBP and we feel pretty sure that the NBP will deliver next week and cut its key policy rate by another 25bp to 4.0%. That said, given the fairly steep slowdown in aggregate demand in the Polish economy, an even more aggressive rate cut might be warranted but for now we believe that the NBP will maintain a cautious stance and cut by only 25bp.

The key reason that the NBP was slow to initiate monetary easing in 2012 -- and even hiked interest rates early in the year -- was that headline inflation was around 4% for the second year in a row, well above the NBP’s official inflation target of 2.5% +/- 1pp. However, as we have stressed earlier, the elevated level of inflation in 2011-12 to a large extent reflected supply-side factors and increases in indirect taxes. If one instead looks at the GDP deflator, which excludes indirect taxes and import prices, inflation was around 2.5-3.0% in 2011-12. Furthermore, given the slowdown in Polish aggregate demand, it is likely that inflation measured by the GDP deflator will drop below 2.5% in 2013. In our view, this fully justifies further rate cuts this year.

We expect the NBP to deliver -- not only next week, but also in coming months -- and we expect the rate cuts to be fairly front-loaded. We expect the NBP to cut by 100bp in total in 2013 (which includes next week’s 25bp cut). That said, the market is already fairly aggressively priced for rate cuts so the impact on the Polish zloty is likely to be fairly limited, which it can be argued would actually necessitate even bolder action from the NBP but we find this unlikely to happen -- at least if our fairly bullish expectations for the global economy come through.

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